Thoughts, Observations, and Analysis of Bardia Mehrabian

Tag Archives: Derivatives

Conducting research is an interesting journey. It can even be an emotional rollercoaster at times. It is fun (at least for me) to see the hypotheses or worldviews I possess in regards to politics, society, etc. is supported by factual evidence. Although, sometimes doing research can completely discredit your beliefs as well. In the case of my last blog post, the journey of doing research uncovered an incorrectly held belief/opinion (once again).

What you saw in the last blog post still remains correct. Both Obama and Romney refuse to address or lower the exorbitant defense budget and they both do not address the giant subsidies the United States pays to special interests, which burns a hole in our national debt. However, my intention when I first wrote the blog was to add a third piece as well. I was going to write that both candidates have not put legislation (or proposed/supported legislation in the case of Romney) into place that addresses the economic fubar that got the entire country into the economic disaster we are currently in. Had I included that into the blog without doing the proper research, I would have been wrong.

The reality is that President Obama did address the horrific wall street practices that brought the United States economy to a near standstill (wiki of Dodd-Frank). In fact, he addressed it emphatically. And, if you’re a capitalist…excuse me…a smart capitalist, you will know how important the passing of this bill was and how important it was in stopping the bleeding of the American economy. If you don’t know, let me break it down:

When Bill Clinton acquired the presidency, he wanted to prove that he was a pro-business Democrat. So his administration began unraveling various government regulation that oversees wall street in the name making it easier for business to do…well…business.

The detrimental piece of legislation that allowed wall street to run wild was the Commodity Futures Modernization Act, which allowed all derivatives to be unregulated and expressly forbade the CFTC (Commodity Futures Trading Commission) from regulating it.

What are derivatives? — Wiki here, but the way Lawrence Lessig explains it is easier to understand:“Derivatives are assets whose value is derived from something else, where ‘something’ could mean literally anything. I could have a derivative that pays me if the price of gold falls below $1,000 … A derivative is just a bet entered into by two or more parties. The terms of the bet are limited only by the imagination of the parties … Derivatives serve a valuable purpose. As with any contract, [the] aim is to shift risk within a market to someone better able to carry it.

When derivatives became unregulated, there was no oversight to see if whether parties (bankers, investors, hedge funds, etc.) contracted/bound themselves to derivatives so risky that it became detrimental to the overall macroeconomic structure. This is precisely what happened with the mortgage bubble and collapse of 2008 (click the link!!), which subsequently caused financial firms to go under (Lehman Brothers) and caused General Motors to beg the government to bail them out because Wall St. would no longer let them borrow money for their bad business model.

As a result of all this, President Obama championed an overhaul of the deregulated financial sector of the United States and pushed Congress to pass a financial reform bill, which it did with Dodd-Frank. The most important piece to that bill is the Volcker Rule, which keeps banks (or an institution that owns a bank) from amassing too much risk and participating in hedges or derivatives that could be deemed too risky without having adequate insurance or capital to support those risks. It also prevents banks from engaging in investments that are not deemed to be in the interest of its clients (conflict of interest).

“As a result, this election offers American voters an unedifying choice. Many of The Economist’s readers, especially those who run businesses in America, may well conclude that nothing could be worse than another four years of Mr Obama. We beg to differ. For all his businesslike intentions, Mr Romney has an economic plan that works only if you don’t believe most of what he says. That is not a convincing pitch for a chief executive. And for all his shortcomings, Mr Obama has dragged America’s economy back from the brink of disaster, and has made a decent fist of foreign policy. So this newspaper would stick with the devil it knows, and re-elect him.”